Cryptocurrency and tax – hard forks

As many readers would be aware, investing in cryptocurrencies isn’t always limited to the traditional buy/hold/sell strategy. Cryptocurrencies are a (relatively) new and nuanced asset class, which can be applied and used in many ways that other assets cannot. There are also a number of events, such as forks, that are unique to cryptocurrencies.

It is important for those holding or investing in cryptocurrencies to understand that all of these events and the various applications can affect, or give rise to, tax implications. Unfortunately, there is little relevant guidance from the Courts, and only broad guidance from the Australian Taxation Office (ATO), as to when these tax implications will arise and how they will affect individual taxpayers.

This article discusses some of the tax implications of hard forks.

The important message to take away is that while the ATO has progressed its thinking and guidance regarding hard forks, the circumstances of each hard fork will often determine the tax outcomes for investors and there are some scenarios where there is little public guidance from the ATO.

Unfortunately, when it comes time to prepare your tax return you may still need to get professional advice.

Hard forks

In very simplified terms, a ‘hard fork’ occurs where a cryptocurrency’s existing programming is changed, resulting in an ‘old’ and ‘new’ version of the programming and cryptocurrency. When such a change is made, it is generally up to users to determine whether they will adopt the ‘new’ cryptocurrency.

The ‘old’ cryptocurrency continues to exist for as long as users transact with it and those transactions are verified by the network. The success of the ‘new’ cryptocurrency generally depends on whether the changes to the programming result in a better cryptocurrency (e.g. faster transaction speed, more secure).

The ATO provides some high level guidance on its website. Specifically, the ATO states that where new cryptocurrency is received as a result of a hard fork (for example, Bitcoin Cash being received by Bitcoin holders), taxpayers do not derive ordinary income or make a capital gain at that time. Rather, a capital gain will arise when the new cryptocurrency is disposed of, and, for the purpose of determining any capital gain, the new cryptocurrency will have a nil cost base.

Whilst the practical outcome of the ATO guidance would be welcomed by taxpayers, we strongly caution reliance upon this guidance without further analysis. This is particularly because the ATO guidance is not legally binding upon the ATO, and also because in our view, the tax law does not neatly apply to hard forks.

For example, the ATO guidance does not elaborate on what, if any, CGT events occur at the time of a hard fork or whether an analogy is drawn between a hard fork and any other commercial transactions that have known tax implications.

The ATO further states in its website guidance that if the new cryptocurrency is held as an ‘investment’ for 12 months or more, taxpayers may be entitled to the 50% CGT discount. However, the ATO does not clarify whether the new cryptocurrency inherits the acquisition date of the old cryptocurrency, or the date of the fork, in terms of when the 12 months commences.

In addition, it seems unlikely that the ATO will accept that the new cryptocurrency would be held as a personal use asset (and therefore entitled to the personal use asset exemption) even where the original cryptocurrency is held as a personal use asset. We consider that the correctness of this position is subject to challenge.

The above issues may become important when it comes time to prepare your tax return, and calculate your specific capital gains/losses, assessable income and deductions.

What should you do?

If you held cryptocurrency during a hard fork, you may need to seek advice about the specific tax consequences that apply to your circumstances. While you may not have to pay any tax, you still have an obligation to prepare your tax return correctly.